IRA vs 401(k), Should You Rollover?

IRA vs. 401 (k) , should I rollover my previous employer’s 401 (k)?

I am contributing to 401(k) plans up to 5% of my salary to get full employer match. I am also contributing $5,000 annually to an IRA account. If I leave this job and join another one I’ll have another 401 (k) account from my new employer.

From TD Ameritrade to ETrade, all IRA administrators run incentive programs to encourage people to roll over. I am trying to find an answer to the question:

Should I leave my money where it is or should I roll it over to Individual Retirement Account?

While there are benefits and drawbacks to both options. IRA seems more flexible, where as, 401(k) is easier to tap in to during an emergency. But that’s not all about the differences.

Let’s do some homework before making a rollover decision.

Before going on to the comparison, let’s be clear that this article is not about where you should put more money from your paycheck. You should contribute to 401 (k) to take 100% of employer match.

Another point to consider, you can’t contribute more than $5,000 a year in an IRA (including Roth IRA), where as 401 (k) allows much more contribution limit.

I contribute to IRA to have more investment options and to have some tax free money in my retirement through Roth IRA.

This article is about answering the question; should you rollover to IRA or you maintain your 401 (k) balance till retirement?

For those contemplating the benefits and drawbacks of rolling over some or all of their 401(k) savings into an IRA, here are some things to consider:

Emergency Cash (Benefit – IRA)

You can borrow from the 401 (k) account without penalties if you are still working. If you leave your job or are laid off before age 55 and can’t repay the loan, it is treated as an early withdrawal which requires regular income tax and a 10% penalty.

But investors can take early distributions from their 401(k) accounts and avoid the 10% penalty if they are laid off after turning 55. If you’re laid off before 55, the best thing is to leave your money in a 401(k).

Early withdrawals from IRA and 40 (k), alike, are subject to income tax (except in the case of a Roth IRA, which requires after-tax contributions), which could put a dent in your nest egg.

IRA account holders can withdraw funds before retirement (via SEPP program) without penalties by setting up a series of equal withdrawals over time.

You can also withdraw from a traditional IRA without penalties once a year provided you repay the funds within 60 days. Your have cash when you need for an emergency. But, funds that aren’t repaid within 60 days are subject to a 10% penalty, in addition to ordinary income tax if you are younger than 59½.

Contributions withdrawn from a Roth IRA are not subject to income tax, penalties or the 60-day restriction, if the withdrawal is made for certain qualifying expenses.

It also makes sense to do an IRA rollover if you need to use some of the money for educational expenses, you are still require to pay the usual tax on the withdrawn amount but you are exempt from paying penalty.


Beneficiary designation (Benefit – IRA)

Second marriages and marital problems may be among the reasons to consider an IRA rollover.

Surviving spouses automatically are entitled to 401(k) funds if account holder dies. That could be a problem if you have children from a prior marriage and want them to share in your retirement savings. You can only change the 401(k) beneficiary if your spouse notarize her consent.

On the other hand, IRAs provide greater range of flexibility in terms of beneficiary designations; you can have as many as you need.

Estate Planning (Benefit – IRA)

An opportunity for your estate/heirs to accumulate tax-deferred wealth is a significant benefit to consider an IRA rollover.

The beneficiary of an IRA can take small, taxable distributions over the course of his or her life expectancy, while allowing the remaining funds to accrue on a tax-deferred basis. Most 401 (k) administrators do not provide this flexibility although the law allows for it.

Most 401(k) plans force heirs to take assets after the account holder dies.

Choices, Transparency (Benefit – IRA)

The range of investment choices available through a 401(k) plan is an important factor to consider when contemplating an IRA rollover.

If you need to invest in more fixed-income options, 401(k) plan offers only a money-market fund and a bond fund. Foreign bond funds, accessible through an IRA, could offer higher yield.

401(k) participants who are still working can roll over funds into an IRA. This strategy can increase investment choices and benefit older investors who are still employed.

Potentially high 401(k) fees can also be a concern. While fees for IRAs are clearly outlined, they often are difficult to assess in 401(k) plans because they generally are factored into the overall return. Fees tend to be higher if an insurance company, rather than a mutual-fund company, is administering the 401(k).

This may change as a new law in effect, that will require plan administrators to disclose all 401(k) fees. On your 2012 401 (k) statements, you are expected to see these fees.

Stock Options (Benefit – 401 (k))

I have stocks options accumulated in my 401 (k). They are so less in number and value, that it doesn’t make a dent if I decide to rollover tomorrow. But this can make a huge difference if you have significant stocks in your 401 (k)

It’s rather better by moving stock to a taxable account and pay a capital gains tax on the cost basis of the stocks rather than rolling them over to IRA where normal income tax rate would apply later on.

If stocks are kept in 401 (k) account till one dies, the new cost basis is set up for the heirs,  the value of the stocks on the date of death. So, during life time, all appreciation in stock value are tax-free!

Except stock options, you can still rollover rest of your assets.

Conclusion on IRA vs. 401 (k)

If you decide that an IRA is a better option for your retirement savings than a 401(k) is, be sure to transfer the funds correctly.

Set up the IRA first and then transfer the funds directly to that account through your plan administrator.

Don’t transfer funds to a non-retirement account. You’ll have 60 days to roll the funds back into an IRA in the event of a  deposit to wrong account. If you fail to do so, you have to pay tax and penalty on the withdrawal.

Please keep it in mind that rules about IRA or 401 (k) constantly changes, so, always be aware of latest changes to federal regulation and policies.

I will continue with 401 (k) for now till I switch the job. Once and if I switch I would definitely roll over. What about you, readers?

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  1. says

    Really interesting thoughts here; I rolled over my 401(k) to an IRA when I left my full-time job, but never considered doing it otherwise. You bring up a lot of points I hadn’t even thought of. What are your thoughts on converting an existing IRA to a Roth?

    • says

      But you have to repay the loan with interest. That means you will pay interest to borrow your own money. And, I told you you’ll eventually become a PF blogger :)

  2. says

    Should be very simple. Contribute to 401(k) while at the employer and rollover to IRA when you leave. Once you roll it over you will have more control of your money seeing that a lot of plans limit your options.

  3. says

    I just have one 401K and I am sticking to it for awhile. I am not planning to opening an IRA because I just don’t want to get involved with investing. Not yet! I need to pay all the debt first.

    • says

      Sure, do what’s best suited to you. This is useful when you switch jobs and have another 401(k) with your new employer.

    • says

      Definitely but when its the matter of life and death I would first try to live rather than a hefty retirement saving.

  4. Con-Man says

    There are some considerations NOT to roll over, or as stated in the post: Benefit – 401k. One was alluded to in the post, but its importance was not highlighted well: if you leave your employer after age 55 you can take distributions penalty free. The other is if you plan to be in a lawsuit, as 401k has ERISA protections. I find the second reason to be the weaker of the two (and I don’t ever plan to be in a lawsuit, but who knows?!). And ceteris paribus, I would take the ERISA protections. But not over lower fees and the investment options I like.

    And don’t think a judge won’t slap a QDRO on you just b/c you rolled over to an IRA.


    • says

      Your comment id is looks suspicious :) I love to see you actually read and understood the post. Din’t just comment for the sake of it. Really loving your well thought out comment here.

      Keeping money in 401(k) can make taking retirement at 55 easier, compared to IRA. Also not many are good investors, having choices to invest can backfire if you are too much ambitious in your investment.

      Better if people assess their self ability and take informed decisions. I put down pros and cons, now its readers’ responsibility to choose the right path.

      • Con-Man says

        Hey, just trying to help with somethings you missed. It’s true 401k’s can have penalty-free withdraws if you end employment after age 55, not just get fired. Certainly a great benefit for leaving money your 401k.

        It’s also true that 401k has protections under ERISA, so protections from lawsuits under a federal law.

        Also, some 401k’s offer excellent investment options. I had access to institutional class funds, which had expense ratios coming in around 0.07%.

        Also, there can be some special benefits of keeping funds in a 401k. For instance, some plans offer the option to use 401k funds to buy further into a pension (for the fortunate!).

        While I agree for most people rolling over is the thing to do (and I actually just did rollover to an IRA). But, there are some interesting things 401k’s offer, and I think there is some merit to mentioning these things.

  5. says

    I’ll rollover my 401k to an IRA when I leave my job. You never know when your employer will change the 401k plan. If you’re not there anymore, you won’t pay as much attention to the 401k and may miss some important announcement. With an IRA, you have total freedom to buy and sell any equity. It’s much better than leaving your money with your old employer.

  6. says

    Very nice breakdown of the elements. I have read in other magazine articles that leaving your money in your old 401k plan may be the best option on the principle of fees alone. Although I am not looking to switch jobs, your analysis is very helpful in understanding the differences.


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